Commentary and musings on the complex, fascinating and peculiar world that is securities regulation

Friday, October 31, 2014

SEC Asks Supreme Court to Deny Review of Disgorgement Order

The SEC asked the Supreme Court to deny review of an appeals court ruling that ordered disgorgement in an SEC enforcement action. In a brief, the SEC noted that a Fourth Circuit panel said that not all intervening market events or conditions will suffice to break the causal chain between illegal activities and subsequent profits for purposes of disgorgement of illicit profits. The appeals court thus did not treat principles of causation as irrelevant, posited the SEC, but simply recognized that an event, here the receipt of large profits from their ultimate sales of target company stock in a tender offer, can have more than one cause. Thus, even if petitioners had successfully demonstrated that their profits were attributable in part to intervening market events, those profits could also be attributable to petitioners’ own unlawful conduct.

The Court has been asked to answer the question of whether the court of appeals correctly affirmed the district court’s order that petitioners disgorge profits that the district court concluded were caused by their violations of securities laws. The case is set to be considered at conference on November 14, 2014, after which the Court will decide whether or not to grant certiorari. Teo, et al. v. SEC, Dkt. No., 14-19.

In SEC civil enforcement actions, federal courts employ a three-step burden-shifting approach to determine the amount by which a defendant has been unjustly enriched. In the first step, the SEC must establish an amount that is a reasonable approximation of profits causally connected to the violation. In the second step, the defendant has the burden clearly to demonstrate that the disgorgement figure established by the SEC is not a reasonable approximation. In the third step, the burden shifts back to the SEC to rebut the defendant’s evidentiary showing.

After a jury trial in federal court, the petitioners were found to have violated antifraud and shareholder reporting provisions of the Exchange Act. Employing the three-prong test, the appeals court concluded that the petitioner, a holder of target company stock, had not demonstrated that the tender offer was an intervening event that broke the causal connection between their violations and the profits at issue.Disgorgement. In affirming the disgorgement order, the appeals panel rejected the contention that the tender offer had broken the causal connection between petitioners’ illegal conduct and the profits received as a result of the stock sale. The panel agreed with the district court that the SEC had produced evidence demonstrating that petitioners obtained over $21 million in profits from the portion of the shares that were tainted with reporting violations, and that this evidence presumptively demonstrated a reasonable approximation of the profits arising from transactions tainted by the fraud and reporting violations.

The petitioners asked the Supreme Court to decide if defendants in SEC enforcement actions can be ordered to disgorge profits earned as a result of intervening events unrelated to their securities violations. The SEC contended that review of that question is not warranted because it is not squarely presented here and is not the subject of a conflict among the courts of appeals.

Petitioners do not contest the court of appeals’ primary rationale for affirming the disgorgement order, which is that they presented insufficient evidence to establish that the relevant profits were attributable to an intervening event unrelated to their illegal conduct. The shareholders instead challenge the court of appeals’ alternative rationale that, even if the tender offer was the most direct cause of the profits that were ordered to be disgorged, those profits were also attributable to petitioners’ securities law violations, since accurate reporting of petitioners’ trades would likely have triggered the poison pill and thereby prevented petitioners from realizing those profits. Besides being unnecessary to the court’s ultimate decision, reasoned the SEC, that analysis was correct and consistent with other appellate authority. Thus, the petition for a writ of certiorari should be denied.